Monday, 25 January 2016

Bear market unlikely to trigger U.S. recession, history shows

Is the carnage in stock markets a prelude to U.S. recession? History says no — with a caveat.

Since the end of World War Two, all 11 recessions have coincided with falling stock prices. But not every bear market has been omen of an impending recession. The bears have run wild on Wall Street in a number of instances — 1962, 1965, 1971, 1976-78, 1987, 1998, 2002 and 2011 — without any ill effects on Main Street.

The key, of course, is the underlying health of the economy. The U.S. has easily brushed off Wall Street havoc when the economy was doing fairly well, as it is now, despite the panic among investors.

“It’s easy to sour on the economic outlook when really your stock portfolio is what’s making you a little queasy,” said Scott Anderson, chief economist of Bank of the West.

The real economy looks a lot different.

Companies are still adding more than 200,000 new jobs a month. Inflation-adjusted incomes are rising. Car sales have hit a record high. Home sales are at a post-recession peak. Consumer confidence is the highest since 2007, buoyed by the cheapest gasoline prices and lowest unemployment rate in years.

Those are not signs of impending doom.

To be sure, the current expansion will eventually end. The U.S. recovery is now 67 months old, exceeding the postwar average of 58 months. And some important segments of the economy are weak, such as energy producers, retailers and manufacturers.

The uber-strong value of the dollar, for instance, has done a number on manufacturers and other large American companies that do lots of business overseas. Exports sank in 2015 and profits have taken a hit, prompting firms to trim investment.

Those pockets of weakness are expected to contribute to a disappointing fourth-quarter report on U.S. gross domestic product. Economists polled by MarketWatch forecast GDP will slow to a 1.1% annual pace from 2% in the 2015 third quarter and 3.8% in the second quarter.

But it’s hard to see the kind of deep problems that led to the last recession. Oddly as it may sound, one reason is the lackluster pace of growth in the current six-and-a-half year-old expansion — the slowest in the postwar era.

The U.S. has grown just slightly more than 2% a year since exiting the Great Recession in mid-2009 and it has yet to reach 3% annual growth, a mark last topped a decade ago.

“A slower expansion means we probably haven’t built up excesses that often lead to recession,” said Gus Faucher, senior economist at PNC Financial Services.

Make no mistake, though. The odds of recession are likely to rise if U.S. and global markets remain weak or fall further. That’s because of what’s known as the wealth effect. Individuals and companies tend to spend and invest less when their net wealth or market valuations decline.

What’s most worrisome are conditions in China, the world’s second largest economy. The stock-market rout in the U.S. was triggered by a bear market and evidence of a slowing growth in the Asian giant.

Conventional wisdom suggests that trouble in China won’t cause big problems for the U.S. Most of what Americans buy and sell is produced in this country, after all.

But China underpinned the global recovery after the financial panic of 2008 and faltering growth could cause a chain reaction that topples the economies of many other countries. Even the U.S. would not be immune to such a broad-based fallout.

“Countries hit by the shock can transit their weaknesses to others through trade links,” noted Adam Slater, lead economist at Oxford Economics.

The growing importance of China in the global economy is a reflection of the waning power of the U.S. The nation’s economic vulnerability to the rest of the world probably more closely resembles conditions of the 19th century than the brief era after World War Two when America seemed like a self-contained economic fortress.

In 1873, for instance, a roaring U.S. economy in a post-Civil War building frenzy fell into depression after a global panic whose origins traced to a stock-market crash in Austria.

China could have the same kind of effect in the 21st century. “China needs to continue to do OK and not have a hard landing,” said Phil Orlando, chief equity strategist at Federated Investors.